Blockchain 2019: Making Sense of Uncertainty in the Regulatory and Compliance Landscape

In the ICO boom of 2017 & 2018, dozens of exciting decentralized applications demonstrated innovative blockchain solutions with huge economic promise. In less than 2 years, Initial Coin Offerings (ICOs) generated well over $12 billion USD and continue to pick up fundraising attention. But it’s not all ICOs and Lambos. According to a 2018 report, 80% of ICOs are scams and only 8% of ICO tokens make it onto crypto exchanges. Moreover, the number of daily average users for DApps underperforms valuation hype and the SEC is diligently pursuing ICOs that broke securities law. Taking into consideration General Data Protection Regulation (GDPR) and new laws like the EU’s ‘disastrous’ copyright directive, which seeks to impose stricter, more burdensome fines and penalties for intellectual property non-compliance, the disparity between innovation and compliance looms large.

In ICOs, Securities, and Utility Tokens: Getting Ahead of the Compliance Curve, I explained how regulatory uncertainty complicates crypto compliance. Complications included the commercial challenges that arise from jurisdictional confusion and hearings indicated a possible path forward for tokenized securities that align with current regulations. Lately it seems that regulatory updates concerning blockchains, decentralized applications (DApps), or cryptocurrencies come out every day. The simple reality is that our global piecemeal framework gives investors pause and leaves a lot of room for interpretation. While the high crypto valuations of late 2017 have crashed and we’ve entered into the early stages of our current ‘crypto winter,’ the global fervor for developing innovative blockchain solutions and distributed ledger technologies (DLTs) shows no signs of slowing down. So, what can we expect in 2019?

Compliance Goes Big Worldwide

On December 6, 2018 SEC Chairman Jay Clayton addressed the trend of unregulated ICOs head on, advising US startups seeking to run an ICO to consult the SEC and appropriate regulatory bodies to ensure securities compliance. Whereas the SEC made an appeal to follow regulations in July, this time the SEC presented a new avenue to discuss compliance. In October, 2018, the SEC opened a new initiative to help fintech startups consult with regulatory leaders called FinHub. The new FinHub covers blockchain and distributed ledger technologies as well as consultation for more traditional fintech products and services. Some distributed products and services stand out more than others. In 2019, I predict there will be a handful of successful FinHub “blockchain graduates” that go live.

Globally, KYC / AML consumer protections startups will make a big splash in the unsexy world of crypto compliance with fintech and banking applications leading the way. Solving niche regulatory considerations takes both legal and technological expertise. Compliance will recenter around regulation-friendly zones like Switzerland, Malta, and Lichtenstein, showing ways for ICOs and Security Token Offerings (STOs) to legally play ball. Expect firms and startups with significant real-world experience and geographically suitable offices to take center stage.

Regulatory compliant stablecoins backed by fiat or commodities like gold and silver (read: not algorithmic stablecoins like Basis) will fare well in a landscape where its easier to understand the immediate use and application of cryptoassets that behave like traditional money more than future-looking DApps, which have struggled to deliver real-world utility.

Institutions Try to Pick Up the Decentralized Pieces

Crypto compliance and crypto activism will straddle the line for use case innovation. Institutional organizations will begin to absorb technical talent as they roll out enterprise blockchain products that address real world use cases. There will be more arguments around the definition of “decentralized” and the intended operation of “decentralized identity” as centralized giants like FAANG and big banks debut their blockchain solutions and lay claim to these terms. Crypto talent will follow suit, or follow their ethos.

Decentralized Identity (DID) and Self-Sovereign Identity (SSI) solutions will go to head to head as institutions try to define new standards for identity using distributed ledger tech and blockchain solutions. I believe there will be a divide between intuitions open sourcing parts of their Federated Identity Management solutions in coordination with each other, and another push for SSI executed by startups like Civic, SelfKey, and uPort that utilize W3C DID standards to build innovative POCs. Ultimately, the platforms with the most developer engagement and real-world DApp utility will set the scene for future development and divide the issue of identity down the lines of W3C standards for DID and independently governed standards for SSI. In 2019, W3C standards will likely lead with successfully deployed use cases; however, the 2 – 5 year outlook is still up in the air in terms of utility and Web 2.0 & Web3 interoperability.

Crypto activists and cypherpunks will continue to stick to their gut developing cutting-edge solutions that institutions are cautious about building out in the open. Privacy-focused cryptos like BEAM will release mainnet implementations of the breakthrough Mimblewimble protocol and revive the palpable fervor that early Bitcoin and crypto enthusiasts caught years back. In late 2019 / early 2020, institutions will likely warm to the win-win privacy and scalability attributes of BEAM’s confidential transactions and try to adopt similar cryptography or integrate the the protocol as a sidechain.

Blockchain Gets Physical

Tokenized Real Estate Investment Trusts (REITs) will come into focus – aiming to improve cost/benefit ratios of traditional REITs – before a landmark lawsuit redefines the practicality of this use case. Real estate is an established business domain with taxable outcomes that are well defined. Pointedly, the IRS sees Bitcoin as a unique taxable property, however, states treat securitized REITs differently. As US tax codes and jurisdictional governance change, I predict that tokenized REITs will not be able to fully comply with real-world demands and we will see a handful of lawsuits in 2019 address the disparity between localized court rulings and blockchain technology involved with decentralized REITs.

Intercontinental Exchange’s Bakkt will continue their delay to distribute physical bitcoin IOUs as potential partnerships amass and traditional market uncertainty heats up. Bakkt’s product debut will likely coincide with the SEC’s Bitcoin ETF decision making by giving credence to the SEC that crypto exchanges can successfully self-regulate. In response, the crypto market may rally and cause early calls for the end of crypto winter.

There will be increased desire for institutional custody solutions that complement Bitcoin ETFs and companies like Bakkt such as realized investments in hardware wallets like Ledger and Trezor. In 2019, additional physical custody solutions like cypherpunk-designed OpenDime wallets will debut as the crypto winter shakes off some – but not all – of the recent cold.